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Cablegate: Imf Negative On Ukraine Budget Bomb

VZCZCXRO7233
PP RUEHIK RUEHLN RUEHPOD RUEHSK RUEHVK RUEHYG
DE RUEHKV #2532/01 3651525
ZNR UUUUU ZZH
P 301525Z DEC 08
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC PRIORITY 6981
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUCNCIS/CIS COLLECTIVE
RUEHZG/NATO EU COLLECTIVE

UNCLAS SECTION 01 OF 02 KYIV 002532

SENSITIVE
SIPDIS

DEPT FOR EUR/UMB, EEB/OMA
TREASURY PASS TO TTORGERSON

E.O. 12958: N/A
TAGS: EFIN EREL ECON ETRD PGOV PREL XH UP
SUBJECT: IMF NEGATIVE ON UKRAINE BUDGET BOMB

REF: KYIV 2434

SENSITIVE BUT UNCLASSIFIED, NOT FOR INTERNET DISTRIBUTION

1. (SBU) Summary. The local IMF office has unofficially told us
that the 2009 budget is "quite negative" and likened the budget's
failure to reign in pension outlays to an "exploding bomb."
According to the IMF, the 2009 budget is based on unrealistic
macroeconomic projections and a 2.97 percent deficit that is far
higher than allowed under the IMF's Stand-By Arrangement (SBA).

2. (SBU) After four attempts by Ukraine's parliament, the Verkhovna
Rada passed a 2009 budget bill on the narrowest of margins on
December 26. President Viktor Yushchenko signed the budget into law
on December 29, but only after extracting a promise from PM Yulia
Tymoshenko that the budget would be amended when the Rada returns
from its holiday recess. Critics appeared from all corners; some
ministries condemned the allocations as spendthrift or misdirected,
while the President's office called the GOU's revenue indicators
"virtual rather than realistic." End summary.


IMF on the Foreseen Deficit
---------------------------

3. (SBU) The IMF's local budget expert Igor Shpak told us on
December 30 that the IMF has yet to voice an official view of the
2009 budget. Unofficially, however, the IMF had a "quite negative"
assessment of the budget, he said. (Note: The IMF recently pulled
its residential representative from Kyiv - see reftel. Shpak is one
of several local employees in the leaderless office and an expert on
macroeconomic and budget issues. End note) The budget's UAH 31.105
billion (roughly $4.15 billion) deficit, projected at 2.97 percent
of GDP, is far higher than is allowed under the IMF's $16.4 billion
SBA, even after acceptable adjustments are made for bank
recapitalizations and project finance. Shpak said that the
maintenance of a balanced budget conditionality would be a "key
subject" for the IMF review team, slated to appraise Ukraine's SBA
implementation in late January.

4. (SBU) Even if the balanced budget conditionality were modified
to account for a worse economic situation since the SBA was approved
in October, said Shpak, the GOU would "still have a bad budget,"
since it is based on unrealistic macroeconomic projections that
underpin the GOU's GDP and revenue forecasts. The government's
estimation that 2009 GDP growth will be 0.4 percent was unrealistic,
he said. (Note: Leading think tanks such as Kyiv-based ICPS have
published baseline growth predictions at or below -5.5 percent. End
note) Furthermore, said Shpak, the budget relies on an
unsustainable amount of domestic borrowing, targeted at UAH 70
billion after the GOU only raised UAH 10 billion in 2008
domestically. Heavy public borrowing, even at far lower levels than
those foreseen in the 2009 budget, would seriously crowd out private
sector borrowing and contribute to the economic downturn, he said.
The biggest drag on the budget is the "exploding bomb" of an
unreformed pension system. Since the Rada voted down legislative
measures that would have capped increases for the most privileged
pension recipients, the GOU will now be forced to increase revenues.
Rada Speaker Volodymyr Lytvyn told the IMF, according to Shpak,
that MPs are prepared to take measures to increase revenues when
they return from their holiday recess in mid-January.

Absentee Support
----------------

5. (U) It took the Rada four attempts to pass the 2009 bill with
226 out of 450 votes - the required minimum. All members of the
BYuT and Lytvyn factions supported the budget, as did 46 OU/PSD MPs.
The Communist faction did not vote, neither did United Center or
For Ukraine MPs.

6. (SBU) The murkiest story coming out of the Rada's deliberations
was the absentia support of three MPs - two from Party of Regions,
Volodymyr Hureyev and Petro Korzh, who defied their faction's
leadership in favor of the bill. After the vote, deputy Regions
head Oleksandr Yefremov claimed that Hureyev and Korzh's voting
cards had been illegally tampered with in their absence. BYuT MP
Ihor Rybakov likewise issued a statement that he had been physically
absent from the session hall during the vote, that his voting card
was with him in his absence, and that the vote marked under his name
had been falsified.

Critics from All Corners
------------------------

7. (SBU) After declaring that "a bad budget is better than no

KYIV 00002532 002 OF 002


budget," President Yushchenko signed the bill into law on December
29. Yushchenko and Tymoshenko arranged that the Rada would take up
possible budget amendments in January, when new economic growth and
revenue figures are released.

8. (SBU) Through Presidential Secretariat deputy Oleksandr Shlapak,
the Yushchenko camp declared the GOU's revenue estimates to be
"virtual rather than realistic," pointing to overrated macroeconomic
indicators that hide an additional revenue shortfall of UAH 20
billion (roughly $2.67 billion) beyond the budget's current
projections. Shlapak criticized the projected growth in state debt
of UAH 103 billion (roughly $13.7 billion) which, as foreseen by the
budget, would be financed by domestic borrowing of UAH 70 billion
($9 billion). Such figures would "more than double" state debt and
increase borrowing seven-fold, money that banks cannot supply,
according to the President's aide. In addition to current outlays
for wages and social programs, an additional UAH 6 billion ($780
million) must still be budgeted for the "imbalanced" Pension Fund,
said Shlapak.

9. (SBU) Ukrainian Defense Minister Yuriy Yekhanurov lashed out at
Rada members who put social programs and subsidies ahead of
servicemen and other budget sector workers. To pay for pensions,
said Yekhanurov, other budget items, including Defense Ministry
programs, have been tapped. The Ukrainian armed forces are due to
receive UAH 7.4 billion (roughly $1 billion) in 2009, against UAH 9
billion in 2008.

10. (SBU) Ukrainian Emergencies Minister Volodymyr Shandra likewise
expressed frustration with the amount of funds allocated to his
Ministry. "I think nobody is satisfied with that budget -- the
state is obliged to ensure social standards, territorial integrity,
and protection from crime for its citizens."

11. (SBU) Comment. Since it was released publicly on December 29,
the biggest question in Kyiv among GOU fiscal policy watchers has
been whether the 2009 budget meets IMF standards. Clearly,
according to the IMF's own expert, the budget fails on this and
other accounts. It's possible that the upcoming program review,
slated for the second half of January, will lead to a modification
of the balanced-budget requirement because the economic situation
has deteriorated far faster than anyone, including the IMF, could
have foreseen in October, when the SBA was approved. However, the
IMF will continue to insist on budget discipline, even if it allows
a modest deficit. Looking forward, we expect the GOU to seriously
test the IMF's willingness to adhere to whatever budget
conditionalities it imposes on Ukraine. The fractured political
landscape will continue to make it difficult for the GOU to take the
painful measures necessary to establish true budget discipline, and
various ministers' outcries over the cuts in their respective
budgets this week indicate that the Rada will face pressures to
increase allocations to key ministries with political clout.
Whether the IMF rolls over on its balanced budget conditionality
will be an early key indicator of its SBA's prospects for success.
End comment.

TAYLOR

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